IN FOCUS

Interview with Mr. Hoe Lon Leng, Author of Decrypted by Lutfey Siddiqi

Hoe Lon Leng brings a unique perspective - that of a practicing, mainstream trader of foreign exchange and rates, especially in emerging markets - to the mystical world of cryptocurrencies. His book - Decrypted - cuts through the sound and fury that often characterizes this space and gives us a dispassionate framework with which to join the debate. We have been industry colleagues ever since we overlapped at Deutsche Bank in the late 1990s. I thought I’d ask him a few questions:

Let’s get the definitions out of the way. What is the best way to describe (a) blockchain, (b) ICOs and (c) Smart Contracts?

The blockchain is a database of transactions that are distributed in servers all over the world. This database is unique in that anything that is written into it cannot be changed. It was invented to keep a ledger on Bitcoin. I also call it an advanced version of the double entry in accounting systems.

ICO is Initial Coin Offering also known as the token sale. It is a sale of cryptocurrency with the specific purpose of raising funds for a specific business idea outlined in a detailed whitepaper (execution plan).

Smart Contracts are programmed operations which cannot be changed or overwritten. Smart Contracts will take action (or inaction) based on the set of rules that it is entrusted with. A series of smart contracts can form a Decentralized Autonomous Organization (DAO), which is precisely what the name suggests.

You highlight the benefit of a decentralized architecture which does not require a central authority. Why is that a good thing? Are cryptocurrencies simply solutions to a problem that does not exist?

Decentralized architecture means power is distributed to the individuals rather than a central authority. One potential benefit is that decisions follow a set of ex-ante rules which are not open to abuse by a central authority. In the book, I talk about New Model Armies by Adam Roberts. And regarding cryptocurrencies, given the way central banks printed money since the global financial crisis, the world needs a store of value that no central authority can damage.

Does bitcoin have intrinsic value or does it simply operate on the principle of the greater fool?

The monetary value of something can be different from its conceptual value. The conceptual-value of Bitcoin, being a decentralized monetary system, pushing the world into a new borderless frontier, is massive.

How do we apply a unit of measurement to that conceptual-value?

Unlike fiat currencies which can be issued via "easing" policies, the total quantity of Bitcoin is fixed at 21 million units. If money is borderless, the demand for Bitcoin (or its prodigy) will be spread over not just one country, but globally in all countries. These limited 21 million units will be in demand by a very large population.

The size of "global wealth" is approximately US$1,143 trillion. If 10% of this value cross into cryptocurrencies, that is a US$114 trillion market cap.

I was under the impression that cryptocurrencies are ideal for money launderers. You say that they are less useful to criminals than cash. How so?

When a transaction of cryptocurrencies takes place, both the sender and receiver’s address and their entire transaction histories are publicly available. “Blockchain is open, and everyone sees everything. Thus, blockchain has no real anonymity. It offers pseudonymity instead,” says Kaspersky Lab’s Alexey Malanov. Cash, on the other hand, is untraceable. Who knows the transaction history of the notes in your wallet?

How are bitcoin, bitcoin cash and bitcoin gold different from each other?

Technically, Bitcoin is the original flavor. But Bitcoin transaction is slow, especially with increasing transaction rates due to rising global adoption. Bitcoin Cash was created to fix this problem. It has a faster transaction speed. Bitcoin Gold was created because of some miners’ (distributed blockchain accountants) claim that large groups are controlling the mining (transaction verification) process. Lost? My book illustrates it using a restaurant analogy: Bitcoin is an exclusive, reservation-only three-starred restaurant, Bitcoin Cash is a long-tabled family diner where guests are encouraged to come in large groups. On the other hand, Bitcoin Gold resembles a self-service buffet where you can collect and cook meals for yourself and others.

Would you say that ICOs are a great way to invest?

This decision depends on individuals' risk appetite. ICO is comparable to funding risky start-ups and carry all the usual risks associated with this kind of investment. The good part is because the tokens go into a tradable exchange, investors can have the ability to exit anytime and in pieces.

What are the risks involved in dealing with cryptocurrencies? Isn’t it all a bit like the Wild West?

There are at least three risks: Liquidity and market value can fluctuate dramatically as it is still a novel concept. Secondly, government regulation can change the rules of the game. Thirdly, lost funds, like lost cash, cannot be recovered.

Wild West? Yes, it is. The market/industry is still new, the bulk of new tokens are under three years old, with Bitcoin almost ten years old. Compare that against traditional currency which has been evolving for a few thousand years. But look at the rate of change that is happening. Until it stabilizes, it will continue to face a lot of teenage-years problems. But it is exactly the wild-wild-west world that can give us opportunities as early investors. Few other markets give us this opportunity.

Finally, what does the proliferation of cryptos mean for central banks and regulators both from the perspective of (a) monetary policy and (b) systemic risk?

As of now, the market for cryptocurrencies is small and unlikely to have much impact on monetary policies. Apart from the possibility of cryptocurrencies replacing traditional money as legal tender, bulk of the challenges regulator face come from the borderless movement of funds. As there is no border in cryptocurrency world, preventing outflow for a country is a major challenge. But if cryptocurrencies grow to significant adoption, then existing monetary policies (interest rates level, rates guidance etc.) could be materially challenged.

Cryptocurrencies are currently thought too small to pose a systemic risk to the financial system, but regulators are watching.

Thank you Hoe Lon,
Lutfey Siddiqi, CFA